U.S. oil and gas producers were unabashedly bullish on their prospects upon entering 2017. Fueling that view was the expected positive impact that two years of underinvestment and a step-up in efforts from OPEC would have on the market's oil glut. In fact, those improving conditions had the industry envisioning that oil would be in the mid-$50s this year, which was high enough that most shale drillers could ramp up their activities and start growing again.
Unfortunately, shale drillers were a bit too bullish, and ramped up way too fast, unleashing a gusher of new oil production in the process. Add in rising output from Nigeria and Libya, which are exempt from OPEC's cuts, and weaker oil demand growth earlier this year, and the glut has barely improved since OPEC announced its efforts to drain the market's supply overhang last November. Because of that, oil has fallen into the $40s, which is forcing producers to take a hard look at their budgets.
A slowdown is coming
Oil-field service giant Halliburton (NYSE:HAL) was one of the first to sound the alarm that drillers are slowing down. Halliburton Executive Chairman Dave Lesar told investors on the company's recent second-quarter conference call that the "rig count growth is showing signs of plateauing, and customers are tapping the brakes."
The signs that the industry is taking a break has become more evident as drillers report second-quarter results, since many are also announcing budget cuts in response to lower prices. For example, leading Bakken Shale producer Whiting Petroleum (NYSE:WLL) stated that it would reduce its spending plan by $150 million, bringing its budget down to $950 million for the full year. As a result of that spending cut, the company will drop two rigs and will only run four for the balance of the year. While still enough to drive output up 14% by the end of this year, that's down from an initial outlook that it would rise 23% by year-end. However, the decision makes sense considering that Whiting has only generated $321 million in cash flow this year, which isn't enough to balance its budget, since it initially based the spending plan on oil averaging $55 a barrel this year.
Meanwhile, Eagle Ford Shale driller Sanchez Energy (NYSE: SN) unveiled plans to reduce its 2018 budget by $75 to $100 million, which would better align spending with cash flow so that it doesn't add any more stress to its balance sheet. As a result, Sanchez Energy will reduce its current rig fleet from eight down to five by the end of this September. Furthermotr, the company will push back the timing of well completions toward to the back half of this year, which will shift that production into the first part of next year.
Even the big players are cutting
The budget cuts from smaller shale drillers like Whiting and Sanchez weren't a surprise given that both companies have elevated levels of debt, making it risky for them to continue outspending cash flow. That said, what has been surprising is that larger, financially stronger U.S. oil companies have also announced budget reductions. This past week alone ConocoPhillips (NYSE:COP), Anadarko Petroleum (NYSE:APC), and Hess (NYSE:HES) all unveiled that they're shaving millions off of their 2017 spending plans.
In ConocoPhillips' case, it's cutting its budget by $200 million, which will bring the new spending level to $4.8 billion. That said, the company still sees production rising 3% this year after adjusting for asset sales thanks to higher well productivity and efficiency gains. Anadarko, meanwhile, said that the "current market conditions require lower capital intensity," which is why it's cutting $300 million out of its budget, pushing it down to a range of $4.2 billion to $4.4 billion. Finally, in response to the current low price environment, Hess snipped $100 million from its budget, which it has now set at $2.15 billion.
This bad news could be good for oil prices
These spending cuts are likely just the tip of the iceberg, with it growing increasingly likely that more drillers will announce reductions in the coming weeks, which should eventually lead to less production in the country. Because of that, oil prices could slowly creep higher in the coming months as the industry digests the impact these spending reductions will have on future output. Those higher prices could provide oil stocks with a boost, as long as drillers don't quickly reverse their decisions and ratchet up spending at the first sign of an improvement in prices.